HUSTON v. UNITED STATES

In this action the taxpayer seeks to recover income tax alleged to have been assessed and collected improperly in the year 1941.

The denial of said deductions resulted in an assessed deficiency consisting of taxes of $ 1593.87 and interest of $ 235.83, a total of $ 1829.70, which the taxpayer paid and now asks for a refund of $ 1823.25. The difference in the amount paid and the amount which is asked for a refund is due to an error admitted by the taxpayer, as an item of income, which was subsequently adjusted and the taxpaid.

An agreed statement of facts, with exhibits thereto, has been filed by both parties. In addition, the Court has taken judicial knowledge of the records in the re-organization and bankruptcy proceeding of the company in which plaintiff was a stockholder and officer.

The plaintiff was a stockholder and President of the Monat Valve and Forge Company. Said corporation was organized to manufacture valves which had been designed by one of its officers and principal stockholders. The company had, in fact, never produced valves in any quantity, most of its efforts being devoted to the improvement of valves which had been designed or in attempts to design and produce new or improved types. It became necessary on July 9, 1939 to file a petition for re-organization in this Court. The hope of the debtor corporation to reorganize rested on the belief that its interest in the patents and patent applications involving valves would become valuable when the valves were perfected.

Under the 1942 amendment, the Internal Revenue Statute relating to the deduction of worthless debts, an income taxpayer seeking to deduct a bad debt in 1941 must show that the debt became worthless in 1941, and if debt became worthless prior or subsequent to 1941, the taxpayer will not be allowed a deduction for bad debts in 1941. Redman v. Commissioner of Internal Revenue, 1 Cir., 155 F.2d 319.

The determination of whether a loss was sustained in a particular tax year requires consideration of all pertinent facts and circumstances, regardless of their objective nature which is what the circumstances showed, or the subjective nature which is what the taxpayer believed.

In other words, in determining whether a taxpayer is entitled to a bad debt or a stock deduction as worthless, for income tax purposes, all pertinent facts must be considered, regardless of their objective or subjective nature. Acheson v. Commissioner of Internal Revenue, 5 Cir., 155 F.2d 369.

1. Bad Debt Claim

Subsection (k)(1) of Section 23 permits the deduction of debts which become worthless within the taxable year.

The advances or loans made by the taxpayer in an effort to keep the company from bankruptcy were ineffective. In addition thereto, there was a deficit in the assets of the company in the latter part of 1940 of at least $ 10,000.00.

Where a taxpayer makes advances of money with the knowledge that the advances would never be repaid, and were not made under legal obligation, they cannot be deducted as ordinary and necessary business expenses in determining the taxpayer's taxable income. Reading Co. v. Commissioner of Internal Revenue, supra.

A debt for federal tax purposes is an unconditional and legally enforceable obligation for the payment of money. Autenreith v. Commissioner of Internal Revenue, 3 Cir., 115 F.2d 856.

Where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on the judgment, a showing of these facts will be sufficient evidence of the worthlessness of the debt for the purpose of deduction. Collector of Internal Revenue v. McKay Products Corp., 3 Cir., 178 F.2d 639.

Th burden which the taxpayer bears to prove that the debt became worthless in a given year is successfully established only when he identifies a transaction occurring during the taxable year, which evidences the change and status of the debt or the debtor, which makes the debt worthless. United States v. S.S. White Dental Mfg. Co., 1927, 274 U.S. 398, 47 S. Ct. 598, 71 L. Ed. 1120.

Having identified this transaction or event, the taxpayer must prove that during the taxable year which preceded it, the debt had value, and that before the end of the taxable year, during which the identifiable event occurred, the debt became worthless. Dunbar v. Commissioner of Internal Revenue, 7 Cir., 119 F.2d 367, 135 A.L.R. 1424.

The circumstances in this case clearly establish that the debtor corporation was hopelessly insolvent long before the year 1941. A declaration of bankruptcy was, therefore, not a prerequisite to the ascertainment of the fact of such insolvency. Friend v. Commissioner of Internal Revenue, 7 Cir., 119 F.2d 969.

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